U.S. monetary policy and income inequality in small open economies

Abstract

We examine the impact of changes in U.S. monetary policy stance on income inequality of open economies. Using a Heterogeneous Agents New Keynesian model with price and wage rigidities, we show that in an expansionary (contractionary) monetary shock by Fed increases (decreases) income inequality in open economies. This impact is much higher in inflation targeting regime than in pegged exchange rate regime. We also find that while the impact of U.S monetary shock on inequality in pegged exchange rate regime is critical function of wage rigidity in the economy, it is independent of wage rigidity in inflation targeting economies. Our analysis indicate that in presence of hand to mouth households, an increase in wage flexibility certainly reduces welfare in in a pegged exchange rate economies. Our empirical estimates confirm our model prediction. More precisely, the estimates produce robust evidence that 100 basis point increase in Fed Fund Rate lower income inequality in open economies by nearly 0.15% over two years.